How and Why to Invest in Real Estate Using a Self-Directed IRA

Make Your Self-Directed Ira the Gateway To Real Estate Investing!

Savvy investors know where their money will generate the greatest return. Many use individual retirement accounts (IRAs) as alternate investments to diversify their portfolios while lightening their tax burden. But traditional IRAs have restrictions, among them a rule that forbids use of IRA funds to accrue personal wealth, which prohibits investments such as real estate, mineral rights, and water rights.

Fortunately there are alternatives, such as the self-directed IRA (SDIRA). Let’s take a look at how a SDIRA works, what its capabilities and limitations are, and how a SDIRA could be your first step on the road to successful real estate investment.

What is a Self-Directed IRA?

A self-directed IRA is basically a variation on the traditional IRA (to which you make tax-deductible contributions and pay taxes when you withdraw money) and the Roth IRA (on which you pay taxes on your contributions but withdraws are tax-free). Unlike a traditional IRA, a self-directed IRA is administered by a custodian or trustee. The SDIRA holder, however, retains full control over the account. The custodian cannot offer research services, professional guidance, or advice, so the management of the account (including all due diligence) falls to the account holder. But so do the gains!

How to Open a SDIRA

Here you may have to do some shopping. Not every institution offering traditional IRAS also offers SDIRAs. Fortunately, many do. Companies currently offering SDIRAs include Millennium Trust Company, Equity Trust, Madison Trust, and The Entrust Group. Once you secure a company, your account will be assigned a custodian/trustee. Again, the custodian is not a broker or investment advisor and cannot offer professional guidance. So as the account holder, you’ll be responsible for all due diligence on the account.

How Can You Use the Money in Your SDIRA?

Because self-directed IRAs have fewer limitations than traditional IRAs, account holders have a broader range of investment options. These may include:

    • Real Estate
    • Undeveloped Land
    • Cryptocurrency
    • Precious Metals (e.g., gold bullion, silver, platinum)
    • Promissory Notes
    • Livestock
    • Mineral or Water Rights

In addition, a SDIRA lets you do a few other things that a traditional IRA does not. For example, you may hold partnerships, tax liens, and business franchises in a SDIRA. SDIRAs are not limitless, however, so you won’t be able to use them to invest in life insurance, S-Corp stock, or collectibles.

Benefits of Using Your SDIRA to Invest in Real Estate

The prime aim of most IRAs and SDIRAs is to provide alternative investments, thus reducing risk, should any one company or industry suffer a setback. Along with diversification, your SDIRA lets you invest in areas off-limits to traditional IRAs, like real estate.

But there’s one common application we haven’t mentioned: the multigenerational investor. Remember we are still talking about retirement accounts here, but many choose to put that money into property that will be both of use and of value to future generations. Experienced investors know that no two marketplaces are exactly alike, and that the best way to safeguard against risk is to diversify. A retiree who invests in real estate through a SDIRA now, can provide a family home, or even a thriving business, for those who follow.

IRS Reporting Requirements

Having a SDIRA is great, but there are some drawbacks. For example, the IRS record-keeping and reporting rules are strict, and if you make an error or omit any documentation, you may be facing IRS fines and penalties. Unless you’re an experienced investor, you may want to partner with a tax pro to help avoid any common IRS pitfalls.

Other Limitations of SDIRAs

SDIRAs are not without rules, and some can be enforced with IRS penalties. Some key prohibitions include:

  • Transfer of assets from your SDIRA to a disqualified person (such as a child)
  • Extension of credit or cash loans to an disqualified person
  • Furnishing goods, facilities, or services to an disqualified person
  • Transfer of SDIRA income or assets to benefit an disqualified person

Is a Self-Directed IRA Right for You?

While a self-directed IRA offers more flexibility, it also entails more responsibility. As the account holder, you’ll be responsible for all due diligence–from researching potential buys to estimating market trends. And like any trustee account, there are administrative fees, typically an annual fee, plus per-transaction fees if you are taking disbursements from the account.

If you are investing in real estate through your SDIRA, remember that, unlike a broker, a custodian cannot simply sell assets like real estate at a keystroke—making this sort of investment ideal for those with a long-term financial strategy.

At Moskowitz LLP, we help investors like you make informed decisions about their futures. We provide the guidance you need to better understand today’s investment climate, offer both legal and tax advice, and help you get the most from your investments. Planning for your financial future? Contact us today!